FOR FAILURE: EARLY LIBERTIES, LATE CRACKDOWNS

Wednesday

Jul 31, 2013 at 12:01 AM

At Bank of Florida, it paid to be an insider.

Directors received more than $100 million in loans and earned many millions more by contracting with the chain of three banks to lease branches, provide architectural advice and oversee computer systems.

When state regulators asked for proof that deals with insiders were good for the bank, and not just good for the directors, they were met with delay, resistance and deception.

Regulators found that executives twice filled out questionnaires with erroneous information and were unable to produce key documents showing deals had been properly vetted, leading them to conclude that Bank of Florida was breaking the law.

Bank leaders say they may have been slow to produce documents but ultimately complied with all requests.

Instead of punishing Bank of Florida executives, examiners gave them high marks for overall management.

Regulators saw wrongdoing and defiance such as this at other banks across Florida in the years before the financial crisis but did little to stop it. Only two of Florida's failed banks were hit with serious enforcement actions in 2006, and 90 percent were given high marks.

But as soon as the real estate market soured and banks began reporting losses, regulators got tough. They issued 13 enforcement actions in 2008 and downgraded more than half of Florida's failed banks.

By then it was too late.

Sixty-eight banks failed during the last five years, and a Herald-Tribune investigation found that more than half of them repeatedly broke rules and regulations meant to protect them.

Most of those rules were common-sense guidelines to keep bankers from hurting themselves.

For example, banks have to make sure they have enough money on hand to cover losses. They are supposed to know a borrower's financial history to determine if he or she can repay. They must adhere to caps on how much money they can lend to each borrower, and they are warned not to use too much depositor money to fund the riskiest kind of loans.

Banks also have to get appraisals on property and are supposed to avoid deals that are overly generous to directors and executives.

During the last decade, bankers often broke these rules and examiners watched them do it.

"They had front-row seats," said Raymond Vickers, a former state regulator and economic historian. "They knew what was going on and they allowed it to happen."

The result was the most serious economic downturn since the Great Depression.

The Federal Deposit Insurance Corp., which protects customers' money when a bank fails, concluded in 2011 that regulators need to act earlier in an economic cycle and take a harder stance against wayward banks to avoid similar calamities in the future.

The U.S. Congress passed sweeping reforms that make banks raise more capital to protect against losses and force executives to rely on data, instead of personal relationships, when they lend money.

In Florida, though, the agency that oversees banks seems to be moving in the opposite direction.

Ten percent of bank examiners at the Office of Financial Regulation have been let go since the peak. Half the offices have been closed. Senior employees have been encouraged to leave the agency. Its second-in-command -- a Naples chiropractor and real estate investor who plays golf with the governor -- cannot take over the top spot because he doesn't have the appropriate license.

Meanwhile, the state's top regulator does not believe that getting tough on bankers is the right approach. He says "more effective, more business-friendly regulation" is the answer.

Critics disagree.

"What we need now is not less oversight," said Benton Eisenbach, a former regulator who oversaw the Tampa Bay region before retiring last year.

"We need to step up and be more hard-nosed than we have been."

A history of failures

Failure is part of the American banker's DNA.

In the 1880s, before there was any type of modern banking regulation, land, commodity and stock market booms preceded waves of bank failures every 15 to 20 years.

That trend continued until the Great Depression, when 270 Florida banks and thousands more across the country were shut down.

Looking to prevent a similar crisis, Congress enacted a series of laws, including insurance to protect depositors and the separation of banking from other financial services to reduce risk-taking on the part of banks.

Relatively few banks failed over the next 40 years. But Depression-era regulations were by no means perfect and got in the way amid the high inflation of the 1970s.

President Ronald Reagan ushered in a new era with laws allowing savings and loans to charge higher rates to borrowers and make riskier loans to developers and speculators.

But regulators stumbled.

Banks and thrifts received fewer exams and excesses went unchecked -- leading to the savings and loan crisis of the late 1980s and early 1990s.

Ninety Florida banks failed during this period, and studies from that time reveal that the principal causes were misconduct by bankers and acquiescence by regulators. Experts concluded that government needed to clamp down on bankers going forward, but that did not happen.

Under President Bill Clinton, the trend toward deregulation continued. Key restrictions were lifted -- among them, a provision of a decades-old rule that prohibited banks from operating other businesses, like insurance or stock brokerages -- and regulators were told to stop being so confrontational.

"Business owners are sick of being treated like criminals," said Vice President Al Gore, who was charged with streamlining government regulations.

His solution: Treat bankers more like customers.

Beginning in 2002, the FDIC implemented its "MERIT" program, which led to shorter, less-intrusive exams.

Through 2007, about 40 percent of all bank exams were conducted in the MERIT program, according to the FDIC. Among those that participated were seven of the 68 banks that failed in Florida.

The program ended in 2008 after examiners complained it stripped them of their authority to investigate banks properly.

"A whole generation of regulators was trained under this program," said Dick Newsom, who served as an FDIC regulator for 17 years. "They were told not to make a nuisance of themselves, to do superficial reviews and do them quickly.

"The idea was to create a kinder, gentler regulatory atmosphere."

Ignoring the regulators

Bankers seized on this "kinder, gentler" environment as an opportunity to dismiss regulatory concerns.

At Riverside National Bank in Fort Pierce, executives ignored regulators who told them to keep better track of $24 million in insider loans. And when examiners asked about transactions with affiliates, the bank refused to turn over information and told regulators it was "confidential."

At Marco Community Bank in Collier County, regulators warned that it was breaking the law by investing too much money in a company that funded the rehabilitation of low-income housing. Instead of cutting back, Marco Community increased its investments -- costing the bank millions when borrowers defaulted.

And at Freedom Bank in Bradenton, regulators told Gerry Anthony to grow slowly when he opened shop in May 2005.

Anthony had been forced out of two other banks over aggressive growth and risky lending. State regulators wanted to prevent that from happening again. But Anthony did not listen.

He grew Freedom to be the biggest bank in Manatee County in less than three years, and regulators say he and members of his board became "argumentative" when management was blamed for an increase in bad loans.

Regulators have a range of punishments they can use to make bankers follow rules. The strongest is a cease-and-desist order that forces banks to comply with regulatory orders or face the prospect of being closed.

With regard to Freedom, Marco Community and Riverside National, the FDIC found that regulators did not take strong action fast enough.

"Regulators felt their hands were tied a little when banks were showing record profits," said Bruce Kuhse, the former general counsel for the Florida Office of Federal Regulation. "They couldn't go to court and get a cease-and-desist order when times were good.

"Banks would have told the administrative law judge: 'We know what we're doing. We're making lots of money. Leave us alone.'"

Delay and take time

Executives at Bank of Florida were especially brazen about rebuffing regulator requests for information about insider deals.

Though not illegal, experts say such deals can signal a conflict of interest and lead to concerns about whether executives are putting their own priorities above those of the bank. A Naples attorney who was also a Bank of Florida director says all of the insider deals were handled properly.

Documents filed with the U.S. Securities and Exchange Commission show a company controlled by director Ramon Rodriguez received $6.2 million for providing computer network support to the chain of banks.

Companies run by Terry Stiles, another director, earned $4.4 million for leasing out space in buildings to Bank of Florida-Southeast, while a company managed by Donald Barber and two other directors garnered $4.8 million by leasing office space to Bank of Florida-Southwest.

In the deal with Barber and his partners, the bank started leasing headquarters space in Naples for $34,000 per month in 2002. But four years later, the price skyrocketed to $94,000 per month and state officials wanted to know whether the bank was overpaying.

They asked bank executives to provide proof that the lease was based on market rates, but executives were slow in responding. The matter was finally settled when directors sold the building to an outside buyer in April 2008.

"Management was unable to provide any written analyses indicating that the various business transactions with insiders were reasonable to the bank and on terms no more favorable than would be offered to a disinterested third party," regulators wrote in 2006.

Regulators also noted that executives twice withheld information when filling out questionnaires about insider deals.

"In 2004, examiners were not aware of the transactions because management failed to disclose them in its response to the officer's questionnaire," regulators wrote in their 2006 report. "At this exam, the officer's questionnaire was also erroneously completed and had to be corrected after the exam began."

Joe Cox, a Naples attorney and former board member, said insider deals were properly vetted. He said executives tried to get regulators the information they wanted and ultimately succeeded.

"You can delay and take time," Cox said. "Sometimes there's miscommunication. But they don't let go. They get your attention and they keep coming back."

'Chickened out'

Nowhere is the timidity of regulators better exemplified than in a 2006 showdown over loans to commercial real estate developers.

This type of loan is among the riskiest a bank can make. There is a lot of money on the line -- millions of dollars to build shopping malls, office buildings and the like. Banks are betting that developers will finish the job and that small businesses will lease or buy the empty space.

Though risky, commercial loans are lucrative. So Florida's community banks became steeped in them and regulators grew worried.

"These loans always crash and burn in a downturn," said Newsom, the former FDIC regulator. "They always do."

The FDIC saw the number of development loans growing to dangerous levels nationwide and tried to put a stop to the trend. In early 2006, the agency proposed a rule that would limit how much banks could lend to commercial developers.

The proposed cap meant that if a bank had $10 million in capital, which is basically the cash on hand to protect against problems, it should lend out no more than $10 million to commercial developers.

The Florida Bankers Association lobbied hard against the restrictions, believing the halt in lending would cause the bottom to fall out of the real estate market. Most Florida banks already far exceeded the proposed limits and the new rules signified they would not be able to make fresh loans.

Together with similar organizations around the country, the FBA poured all its resources into getting the FDIC to back off.

"The FDIC chickened out from doing anything meaningful," Newsom said. "They watered down the policy so that it was nothing more than guidance. There was no consequence for not doing it."

The result was that banks continued to load up on risky development loans even as the real estate market began to falter. In fact, many Florida banks made their largest and worst loans during this period, making the ensuing crisis much worse.

Even the bank lobby now acknowledges it was a mistake to allow commercial real estate lending to continue unfettered.

"Given the benefit of hindsight, it was probably a bad decision," said Alex Sanchez, head of the Florida Bankers Association. "We just didn't think the one-size-fits-all approach of the FDIC was the answer."

Continued deregulation

Bankers give millions to fund the campaigns of political candidates in Florida and beyond.

An analysis of campaign records shows that Florida bank executives, board members and trade groups have donated nearly $9 million to state and federal campaigns since 2000.

This largess allowed bankers to win concessions from Florida lawmakers, such as a law this year that allows banks to speed up the foreclosure process and get struggling property owners out of homes faster.

Also, some of Florida's top financial watchdogs are bankers. Its chief financial officer, Jeff Atwater, spent 25 years in community banking, while its top regulator, Drew Breakspear, was tapped after four decades as an international banker and consultant.

Given the background of Florida's top government officials and so much support from the bank lobby, it should come as no surprise that Tallahassee lawmakers rarely take a hard line against the industry.

Unlike the FDIC, the Florida Office of Financial Regulation has not undertaken a study to determine the causes and consequences of the 68 bank failures that have occurred since 2008.

And Breakspear believes average Americans "who were out of their league in terms of their spending habits" caused the financial crisis, rather than mismanagement and poor decision-making by bank executives.

"Clearly you had government pushing to increase homeownership and there was a lot of pressure that resulted in some people who probably should not have been getting loans," Breakspear said. "As the economy turned down, they were incapable of paying."

A former banker himself, Breakspear acknowledges the need to move quickly against defiant bankers. But he says the cuts to regulatory staff were justified, considering there are 20 percent fewer banks to regulate.

He added that he has strengthened his agency by upgrading computer systems, developing a succession plan and replacing former employees with those who have a combined 200 years of experience.

But in an interview with the Herald-Tribune, Breakspear bridled at the thought of getting tougher on bankers, saying that we live in a free enterprise environment and that "financial regulators must change so they do not stand in the way of banks."

That means Florida will continue down the path of deregulation, and critics worry that this leaves the state vulnerable to another banking crisis in the future.

They say the 10 percent reduction in banking division staff and the loss of nearly half of the OFR's top 23 administrators in the past 12 months have weakened the agency at a time when it should be strengthened.

The No. 2 person in the organization is now Greg Hila, a Naples chiropractor and personal friend of the governor. Hila is not able to fill in for the agency's leader because he does not hold a stock broker's license. But Breakspear defended Hila, saying "he brings vast private-sector business management experience to the OFR" and has improved finances "through visionary budget management."

Critics say Breakspear is following a path laid out by his predecessor, Tom Grady.

"Grady came in with preconceived notions that the OFR was overstaffed," said Kuhse, the OFR's former general counsel. "His goal was to cut a certain number or regulations and a certain percent of personnel to meet commitments to the governor, and he did that.

"He posted his initiatives right off the bat and did not take kindly to pushback. The new commissioner, Drew Breakspear, is continuing that trend today."

The result has been "a serious brain drain" at the OFR, said Linda Charity, a 33-year veteran of the agency and former interim director.

"If you look at the organizational chart, it's completely changed from a year and a half ago," she said.

Missing from that chart are Charity and Kuhse, who said they were fired soon after Breakspear took charge.

Breakspear says the longtime employees left voluntarily. But Kuhse says that isn't true.

"The choice was either be terminated immediately," Kuhse said, "or sign the prepared resignation letter and be able to use two weeks of accumulated leave. I think you could properly describe the departures as forced resignations."

To Kuhse, the decision to oust veterans such as himself reflects the agency's growing appetite to replace hard-nosed state officials with those more amenable to the banking industry's needs.

"I don't know what will happen to the agency now," Kuhse said.

"If the goal is to continue to downsize, I don't think that's good," Kuhse continued. "Without senior officials, historical lessons will be lost."

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